How Local Governments Can Fight Back Against the Foreclosure Crisis

Cities can use local housing codes and land banks to push back against banks’ reckless behavior.

Since the beginning of the economic downturn, Congress has passed numerous pieces of legislation aimed at stabilizing the housing market. Their legislative efforts succeeded in stabilizing financial markets, but foreclosures have continued unabated, affecting families and neighborhoods across the country. While the foreclosure crisis continues to be a drag on the economy, its effects are felt most acutely in communities and neighborhoods.

For the last decade or so, growth in America’s housing stock was driven primarily by investment rather than demand. As a result, there is a surplus in the housing market, which causes many foreclosed homes to sit vacant for years, generating no revenue for their (often institutional) owners who have no intention of occupying the property themselves. Rather, the institutional owners must either pay to maintain the property or let it fall into disrepair. In the many cities where this is the case, it is economically rational for the lender to modify the mortgage, if possible, and allow the current occupants to remain in their home. There are two benefits to such an arrangement: (1) the lender will not be responsible for maintaining the property, and (2) the property will continue to generate revenue for the lender in the form of mortgage payments.

In refusing to modify mortgages, lenders are often acting irrationally. Despite many attempts, the federal government has failed to pass legislation that would force or sufficiently incentivize lenders to modify mortgage principals on a large scale. As a result, foreclosures continue and local governments are left to bear a disproportionate share of the burden. The harms of abandoned property are well-documented: nearby property values decrease, property tax revenues decrease, the community’s safety and health are often put at risk, and a negative perception keeps out new investment.

Not all localities, however, are letting these institutional lenders harm their neighborhoods without a fight. Increasingly, they are holding absentee and institutional lenders accountable for the mess their mindless foreclosures create within their jurisdiction. The most successful approaches have included two components: strong code enforcement and a land bank. Land banks are local, usually governmental, entities that can acquire, hold, and dispose of properties according to community needs and priorities. The best way to explain the process is to walk through the steps.

The mortgagee, often a bank, forecloses a mortgage that the homeowner is no longer paying. The bank may not be able to resell the property, so it sits vacant. This is happening all across the country. The New York Times reported that there were 15,000 abandoned properties in Chicago back in October 2011, most of which resulted from foreclosures. Ideally, the property would not be sitting vacant at all, but the problem of vacancy is compounded when institutional owners fail to manage the property. Most institutional owners, often the big banks, are not well-equipped to maintain properties at the standard required by local housing codes. As a result, it often falls on the local government to board up broken windows and mow overgrown grass.

Here, code enforcement comes into play (which is sometimes supplemented by a vacant property registration system). The owners can be fined when the property does not meet code. The fine must be sufficiently large to give the absent owners an incentive to either maintain or sell the property. If the institutional owner does not pay the fine, it can be placed against the property as a lien. Eventually, non-payment allows the city to foreclose the lien and take the property into its inventory, ideally transferring it to a land bank with expertise in land management to assist in long-term community development.

Alternatively, the banks may choose to donate unoccupied properties in their inventories as a way to avoid paying the steep fines. The case study of Cleveland has been widely publicized in the New York Times and 60 Minutes, among other media outlets. The banks that own dilapidated property in Cleveland, including Bank of America, J.P. Morgan Chase, and Wells Fargo, are so tired of paying fines that they are actually donating them to the local land bank and sometimes paying it up to $7,500 to demolish formerly-occupied properties! The inefficiency of this option for banks is startling and, if banks get their act together, will result in more modifications in lieu of foreclosures.

Cities facing high rates of foreclosure and high rates of property abandonment would be well-advised to adopt this model. Doing so on a widespread basis will have one of two positive effects: either the institutional owner will maintain the property in a way that lessens the harm to the community or the locality will be able to impose large fines and eventually take control of the abandoned property. Without a successful national program to decrease foreclosures, this is the most powerful option local governments can adopt to minimize the effects of the foreclosure crisis.

Kristen Tullos is a Roosevelt Institute Pipeline Fellow and a third-year student at Emory Law School in Atlanta .